When MPR Cut Hurts Economy

Godwin Emefiele
CBN Governor, Mr. Godwin Emefiele

James Emejo takes a look at the rationale behind the Central Bank of Nigeria (CBN)’s resolute decision to retain interest rate at a period when some other economies have cut their benchmark rate as a response to the impact of the coronavirus pandemic

The Monetary Policy Rate (MPR), otherwise known as interest rate is a reference point used to determine the cost of borrowing by commercial banks. It is basically the rate at which the CBN lends to banks.

There had been the clamour for interest rate cut in recent times following the high cost of borrowing from commercial banks, especially as this had continued to make it difficult for small businesses that are catalysts for economic growth to thrive under a hostile operating environment.

Amidst challenges of infrastructure including power, access roads, multiple taxation and affordable finance among others, the provision of cheaper funding especially for start-ups had become inevitable.

The CBN plays a critical role in the direction of interest rate as the MPR represents one of the key tools for monetary policy intervention towards stability.

However, one of the greatest obstacles to the downward review of the benchmark rate in recent times has been rising inflation as it will not be economically healthy for the rate of inflation to be higher than the MPR.

The MPR is currently at 13.5 per cent with the headline index closely at 12.13 per cent as at February, a situation which continues to make rate cuts elusive.

Nevertheless, recent policy interventions by the apex bank, particular bank’s Lending to Deposit Ratio (LDR), Cash Reserve Ratio (CRR) among others appears to have reduced inter-bank lending rates as a result of the ensuing competition among the banks.

However, with the new challenges posed by the coronavirus (Covid-19) pandemic, which had altered global economy prospects, leading to job losses as a result of the lockdowns in several parts of the developed economies, expectations had been high that the CBN will cut the benchmark rate to stimulate growth.

This is particularly so as other developed countries including some developing economies have had to reduce interest rate to the barest minimum and launched several other palliatives to cushion the adverse effects of the pandemic.

Although the CBN had also reeled out an array of policy responses to douse the impact of covid-19, including regulatory forbearance, loan restructuring, and intervention to the health sector among a host of other palliatives, the MPR remained constant.

Analysts had predicted that the apex bank might reduce interest rate to reflect the current economic scenario.

However, the Monetary Policy Committee (MPC) of the CBN had last week resolved to retain the reference rate otherwise known as interest rate at 13.5 per cent and left both the cash reserve ratio (CRR) and Liquidity Ratio unchanged at 27.5 per cent and 30 per cent respectively.

CBN Governor, Mr. Godwin Emefiele, had explained that in holding the monetary policy instruments constant, the committee noted the continued rise in domestic prices; the glut in oil supplies and low oil prices in the wake of the current global shocks; exchange rate pressure and other domestic monetary and fiscal responses to the evolving crises.

Specifically, he said the MPC had considered the “recent actions of the bank, targeted at strengthening the resilience of the financial system and alleviating the initial impact of the crisis. In its wisdom, the committee felt that tightening would result in reining in the rising trend in inflation, and that it would support reserve accretion.”

He explained that monetary tightening would reduce money supply and limit deposit money banks (DMBs) credit creation capacity, thus resulting in increasing the cost of credit, with adverse impact on output growth.

According to him, tightening would also result in a “reduction in aggregate demand as a fall in disposable income results in output compression; whereas at this time, policy emphasis should be on stimulating aggregate supply and demand, both already weakened by COVID-19.”

Emefiele, however, argued that reducing the benchmark rate at this time will compound the country’s inflationary woes.

He said: “With respect to loosening, whereas the committee felt it would stimulate the economy in the short term, and boost aggregate supply and demand, the committee nevertheless, was of the view that there was a need to be cautious in loosening given the fact that it would exacerbate an already worsening inflationary condition, resulting in massive pressure on reserves and the exchange rate.”

He, however, stated: “Based on the balance of these arguments, the MPC, in taking note of the recent actions already taken by the management of the bank in response to the COVID-19, resolved to allow time for the measures to permeate the economy while allowing the pandemic to wear out its plateau before deciding on further supporting policy measures to boost and strengthen aggregate demand and supply in the recovery phase of the economy.”

He added that the choice to hold the rates also factored the subsisting LDR and the DCRR policies, which sterilize excess liquidity in the banking system, hence an increase in the MPR would be counter-productive.

The CBN governor said the monetary policy stance arrived at the meeting took cognisance of the need to address the unfolding unfavourable macroeconomic developments, rein in inflation, support growth and employment through the extant interventions and recent initiatives, check capital outflows and support external reserves accretion as well as dampen pressure and ensure foreign exchange market stability.

However, some analysts who spoke to THISDAY on the outcome of the MPC meeting, particularly its decision to hold the rates, backed the apex bank’s resolve not to tweak the MPR at the moment.

In an interview with THISDAY, Macroeconomic Policy Analyst, Prof. Ken Ife, said the country’s inflationary pressures constituted a major disincentive for interest rate cut adding that “delivering lower interest rates in the market does not necessarily lead to commensurate investment in productive capacity and higher productivity.”

Ife said: “It is true that many economic analysts expected a drop in monetary policy rate which is currently at 13.5 per cent, following the example of the US Federal Reserve Bank and many other western central banks.

“Our challenge in this respect is the high inflation at 12.40 per cent and the need to maintain a headroom for positive interest rate for investments not to vapourise away.

“The other relate to a flurry of interventions now at N3.5 trillion, and by far the most immediate and effective measure coming from the Federal House of Representatives Legislation announced by the Speaker allowing tax rebate to companies to protect jobs at risk. Where you have so much balls in the air, fiscal and monetary, it is advisable to withhold additional fire so as to see how these other measures play out.”

“Also bear in mind that the complexity in our economy has challenged the efficacy of Monetary policy rate as an efficient tool in allocating resources as delivering lower interest rates in the market does not necessarily lead to commensurate investment in productive capacity and higher productivity. Traders simply use these to import more and more cheaper goods, smuggle and dump them through the border,” he added.

Similarly, economist and former Director General, Abuja Chamber of Commerce and Industry (ACCI), Dr. Chijioke Ekechukwu, said it was unlikely that the CBN could have reduce interest rate amidst rising inflation.

He said: “Although CBN through its moral suasion had advocated for rates reduction by Deposit money banks to accommodate the losses arising from Covid-19 pandemic, the low rates of treasury bills, the prevailing deposit and lending rates which have become low since the beginning of the year were reasons analysts thought that MPR should have been reduced.”

According to him, reducing MPR would have increased narrow money and broad money supply, which would have increased demand on imports and put pressure on the very scarce foreign exchange.

“Also, MPR couldn’t have been reduced while the inflation rate is increasing. These were the determining factors considered by the CBN for retaining the MPR,” he added.

On the contrary however, an Associate Professor of Economics at the University of Port Harcourt, Anthony Onoja, said the MPC should have nonetheless reduced MPR to boost investment spending and encourage the banks to lend to businesses and households amidst the current public health crisis.

Onoja told THISDAY:”The decision of the Monetary Policy Committee (MPC) of the Central bank of Nigeria (CBN) to maintain the prevailing MPR at 13.50 per cent against the backdrop of the Covid-19 pandemic globally depicts insensitivity of the monetary policy in addressing the shocks and pains of the Nigerian households and businesses beleaguered by the effects of the pandemic currently.

“The Monetary Policy Rate (MPR) is the benchmark for banks’ lending rate to fund borrowers. Thus, a reduction in MPR should imply a reduction in bank lending rate. Lowering cost of borrowing encourages businesses to increase investment spending. It also gives banks incentives to lend to businesses and households and allow them to spend more. By doing so, it will stimulate output growth and employment generation in the economy as enunciated in the Economic Recovery Growth Plan (ERGP).”

Onoja said: “Lowering of MPR is a pro-growth approach and consistent with global trends. Ideally, a reduction in the bank’s lending rate is expected to result in reduced cost of borrowing and increased access to more funding by the real sector. At a crucial moment as this a reduction in MPR rate is needed to help households and businesses cushion the harsh effects of the Coronavirus pandemic especially knowing fully well that Nigeria is still the current global poverty headquarters.

“I am afraid more deaths of Nigerians at this lockdown era may happen not directly as a result of the pandemic alone but as a result of hunger and poverty which will render a significant proportion of the estimated population of 200 million citizens of Nigeria vulnerable to the impact of the pandemic.”

However, the apex bank had further warned about the huge economic costs of the pandemic which had brought the global economy on its knees.

Speaking at the end of the two-day meeting of the Monetary Policy Committee (MPC) in Abuja, CBN Governor, Mr. Godwin Emefiele, who read the committee’s communique said not only will the coronavirus pandemic result in a health crisis, it further poses a massive economic crisis that will plunge many industrialised countries as well as Nigeria into recession.

The CBN governor warned that the coronavirus pandemic which is a public health crisis will continue to undermine any monetary and fiscal stimulus unless appropriate measures are taken to test, isolate, curtail the spread and treat infected persons while ensuring that migration across the country is prohibited.

Specifically, the CBN governor said available data on the country’s key macroeconomic variables indicated the likelihood of subdued output growth for the Nigerian economy in 2020.

He stated that based on the current down trend in oil prices, projections indicate that the output in 2020 would be less than earlier envisaged, largely as a result of the continued spread of coronavirus, further decline in crude oil prices and reduction in accretion to external reserves, reduced government revenues linked to weak aggregate demand, declining non-oil receipts as well as infrastructural and security challenges.

However, he said these headwinds could be partly mitigated by the timely and effective response of both the monetary and fiscal authorities in containing the spread of the viral infection, the recalibration and adjustment of the 2020 budget to the revised threshold while pegging expenditure to critical sectors of the economy.

Emefiele further called for the adoption of a new fiscal regime to encourage the build-up of fiscal buffers, sustained CBN interventions in selected sectors, enhanced flow of credit to the real sector and deliberate policies to diversify the Nigerian economy